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ACC Ch. 19 & 20
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Gravity
You're wonderful and I love you! - AB
Terms in this set (78)
Constraint
a factor that restricts production or sale of a product
Incremental Analysis Approach (aka Relevant Information Approach)
a method that looks at how operating income would change or differ under each decision alternative. Leaves out irrelevant information the costs and revenues that will not differ between alternatives.
Irrelevant Costs
costs that do not affect a decision / ex. similar fuel efficiency and maintenance ratings
Opportunity Cost
the benefit forgone by not choosing an alternative course of action
Outsourcing
the decision to buy or subcontract a component product or service rather than produce it in-house, can reduce control over delivery time or product quality / ex. offering discounting prices to select customers can upset regular customers and tempt them to take business elsewhere
Relevant Cost
costs that DO affect a decision / are relevant to a particular decision / ex. cost of a truck, deliver of truck, sales tax, insurance premium because they are all incurred in the future and differ between alternative trucks
Relevant Information
aka incremental analysis approach / Expected future data that differs among alternatives / instead of looking at a company's ENTIRE income statement, we will just look at how operating income would change or differ under each alternative
Sunk Cost
always irrelevant to decisions / a past cost that CANNOT be changed regardless of which future action is taken / ex. amount paid for a truck, purchase price of vehicle to be traded in
Target Full Cost
the total cost in developing, producing, and delivering a product or service.
Accounting Rate of Return
a measure of profitability computed by dividing the average annual operating income from an asset by the average among invested in the asset
Annuity
a stream of equal installments made at equal time intervals
Capital Budgeting
the process of making capital investment decisions. companies make capital investments when they acquire capital assets- assets used for a long period of time
Capital Rationing
Choosing among alternative capital investments due to limited funds
Compound Interest
Interest computed on the principle and all interest earned to date
Discount Rate (aka required rate of return)
managements minimum desired rate of return on an investment.
Internal Rate of Return (IRR)
the rate of return(based on discounted cash flows) that a company can expect to earn by investing in a capital asset. the interest rate that makes the NPV of the investment equal to zero.--it ignores cash flow after payback period
Net Present Value (NPV)
the difference between the present value of the investment's net cash inflows and the investment's cost -- based on cash flows, can be used to assess profitability, and takes into account the time value of money -- has NONE of the weaknesses of other two methods
Payback
the length of time it takes to recover, in net cash inflows, the cost of a capital outlay
Post-Audits
comparing a capital investment's actual net cash inflows to its projected net cash inflows
Present Value Index ( aka Profitability Index)
an index that computes the number of dollars returned for every dollar invested, with all calculations performed in present value dollars. Computed as present value of net cash inflows divided by investment.
Required Rate of Return
the rate an investment must meet or exceed in order to be acceptable
Simple Interest
Interest computed only on the principal amount
relevant nonfinancial information
qualitative factors / ex. closing manufacturing plants and laying off employees can seriously hurt employee morale / ignoring qualitative factors can cause managers to make mistakes
Analyzing short term special business decisions
1) focus on relevant revenues, costs, and profits / 2) use a contribution margin approach that separates variable costs from fixed costs
special order considerations
does company have access capacity available to fill this order / will reduced sales price be high enough to cover incremental costs of filling the order / will special order affect regular sales in the long run
regular pricing considerations
what is company's target profit / how much will customers pay / is company a price taker or price setter for this product
price takers
product lacks uniqueness, intense competition, pricing approach emphasizes target pricing / emphasize a TARGET PRICING approach
price setters
product is more unique, less competition, pricing approach emphasizes cost plus pricing / emphasize a COST PLUS PRICING approach to pricing
cost plus pricing
essentially the opposite of the target pricing approach / starts with company's FULL COSTS as given and adds its DESIRED PROFIT
considerations for dropping products, departments, or territories
does product provide a positive contribution margin / will fixed costs continue to exist if co drops the product / are there direct fixed costs that can be avoided if co drops product / will dropping affect sales of other products /
unavoidable fixed costs
fixed costs that will continue to exist even after a product is dropped / irrelevant to the decision because they will not change if company drops product
DO NOT DROP product, department, or territories
if lost revenues from dropping exceed the cost savings from dropping
DO DROP product, department, or territories
if total cost savings exceed the lost revenues from dropping a product, department, or territory
product mix considerations
what constraint stops co from making all units the co can sell / which products offer highest contribution margin per unit of the constraint / would emphasizing one product over another affect fixed costs
which product to emphasize
emphasize the product with the highest contribution margin per unit of the constraint
outsourcing considerations
how do co variable costs compare to the outsourcing cost / are fixed costs avoidable if co outsources / what would co do with freed capacity / variable cost of producing product in house is relevant
DO outsource
if incremental costs of making exceed the incremental costs of outsourcing
DO NOT outsource
if incremental costs of making are less than the incremental costs of outsourcing
sell as is or process further considerations
how much revenue will company receive if sell product as is / how much revenue will co receive if sell product after processing it further / how much will it cost to process further
DO sell as is
if extra revenue (from processing further) is less than the extra cost of processing further
DO process further
if extra revenue (from processing further) exceeds the extra cost of processing further
in making SHORT TERM decisions, you should...
separate variable from fixed costs
when making decisions, managers should...
consider revenues that differ between alternatives
when pricing a product or service, managers must consider which costs...
variable costs, manufacturing costs, and period costs
cost of making and selling one of its products exceeds the target full cost of that product, it WOULD be logical to...
attempt to reduce variable costs, willingness to accept lower return on company's assets, and attempt to reduce fixed costs // it WOULD NOT be logical to attempt to increase selling price
capital budgeting
process of making capital investment decisions - companies make capital investments when they acquire capital assets -- est. must consider many unknown factors (changing consumer preferences, competition, state of economy, gov regulations)
capital assets
assets used for a long period of time
capital investments
buying new equipment, building new plants, automating production, and developing major commercial websites - require large sums of money
capital budgeting analysis
payback period, accounting rate of return ARR, net present value NPV, internal rate of return IRR
payback period & accounting rate of return
fairly quick and easy and work well for capital investments that have short life span (such as computer equipment and software that may have useful life of 3-5 yrs) -- used to screen potential investments from those that are less desirable -- two methods are inadequate if capital investments have longer life span bc they don't consider the time value of money
payback period
provides mgt with valuable info on how fast cash invested will be recouped -- most likely not be affected by a change in salvage value
accounting rate of return
shows the effect of the investment on the company's accrual based income -- only one that uses accrual based accounting
net present value & internal rate of return
factor in the time value of money so they are more appropriate for longer term capital investments -- mgt often uses a combo of methods to make final capital investment decisions -- incorporate compound interest by assuming that companies will reinvest future cash flows when they are received
net cash inflows
desirability of a capital asset depends on its ability to generate net cash inflows - inflows in excess of outflows - over the asset's useful life
operating income based on accrual accounting
contains noncash expenses such as depreciation expense and bad debt expense
cash inflows
include future cash revenue generated form investment, any future savings in ongoing cash operating costs resulting from the investment, and future residual value of asset -- inflows are netted against investments future cash outflows
capital budgeting process
1) identify potential investments (new technology & equipment that may make co more efficient, competitive, and profitable) -- 2) further analyze potential investments using net present value or internal rate of return
capital rationing
used bc of limited resources and co must choose among alternative capital investments -- co may decide to wait 3 years to buy certain equipment bc it considers other investments more important
post audits
after investing assets, co compare the actual net cash inflows generated from the investment to the projected cash inflows -- help companies determine if investments are going as planned & deserve continued support or if they should abandon project and sell assets
payback period
length of time it takes to recover, in net cash inflows. the cost of the capital outlay -- shorter payback period = more attractive the asset
criticisms of payback period
it focuses on only on time, not profitability -- considers only those cash flows that occur during period, ignores cash flows that occur after period
accounting rate or return ARR
focuses on operating income, not net csh inflows, an asset generates -- measures average rate of return over the asset's entire life -- can be used to assess profitability, but ignores time value of money
accounting rate or return ARR
average annual operating income from asset divided by average amount invested in asset
payback period if cash flows unequal
amount invested divided by expected annual net cash inflow
time value of money
NPV and IRR are used -- depends on the principal amount (p), number of periods (n), and interest rate (i)
principal (p)
amount of the investment or borrowing - stated as single lump sum or annuity (ex. if you win lottery you have choice of receiving all winnings now in lump sum, or receiving series of equal payments annuity)
annuity
stream of equal installments made at equal time intervals under the same interest rate
number of periods (n)
length of time from the beginning of the investment until termination -- all else being equal the shorter the investment period the lower the total amount of interest earned
interest rate (i)
annual percentage earned on the investment
simple interest
interest is calculated only on the principal amount
compound interest
interest is calculated n the principal and on all interest earned to date -- assumes that all interest earned will remain invested and earn additional interest at the same interest rate
capital rationing
because resources are limited, companies are not always able to invest in all capital assets that meet their investment criteria
profitability index
aka present value index -- (present value of net cash inflows + investment) -- computes the number of dollars returned for every dollar invested, with all calculations performed in present value dollars
residual value
many assets yield cash inflows at end of useful life because they have RV -- co's discount an investments RV to its present value when determining total present value of a project's net cash inflows -- discounted as single lump slum because it'll be received only once when asset is sold
sensitivity analysis
capital budgeting decisions affect cash flows far into future -- managers want to know if decision would be affected by any major assumptions -- ex) changing discount rate from 14% to 12% r 16% -- changing net cash flows by 10%
positive NPV
means that project earns MORE than the required rate of return -- higher IRR means more attractive project is
negative NPv
means that project FAILS to earn the required rate of return
payback method
easy to understand, based on cash flows, and highlights risks -- it ignores profitability and the time value of money
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